No Greek Revival

Europe's transformation from a war-torn wasteland into a rich, peaceful confederation of nations was one of the great political achievements of the 20th century. The 21st-century effort to broaden and deepen that project, through the expansion of the European Union and the more robust political integration of its members, is one of the most ambitious efforts of our own time. The result is the world’s largest economic area and a continent that features a kinder, gentler social model than the one prevailing on this side of the Atlantic. In a number of ways, this united body has weathered the economic downturn better than the United States. But as the recession drags on, the EU’s underlying approach is showing some serious flaws—experienced most acutely as a crisis over the Greek budget deficit—and threatening both the viability of the EU and the global economy as a whole.

The EU's problem is currently manifesting itself as a series of looming debt crises in Portugal, Ireland, Greece, and Spain -- the so-called PIGS. Virtually all countries have seen budget deficits soar as the recession has reduced tax revenues, increased burdens on social services, and led to fiscal-stimulus programs. In many countries, like the United States, Japan, and Germany, broad investor confidence in the timely repayment of debts has ensured that the cost of financing these deficits is low. The debt of these big countries is regarded by investors as a safe haven. To some extent, a rise in their interest payments would be a symptom of something good -- revived investor confidence in the public sector and reduced demand for super-safe investments.

But for smallish countries with bad reputations in the eyes of investors, things look different. Investor doubts about Greek debt are a specific vote of no confidence in Greece.

This gets particularly problematic, because the degree of confidence investors have in a country is both a cause and an effect of the financial burden of its existing debt load. When Greece starts looking shaky, the interest rate it needs to pay on its deficit goes up, which makes the country look even shakier. This cycle can push a vulnerable country into a default situation. Worse, when countries are perceived as being similarly situated, crises can become contagious. If Greece defaults, then investors will grow more leery of Portugal, Ireland, and Spain, which in turn could push those countries to the brink. And failure in Spain would gravely threaten Italy, at which point even solid budgeters like France, Germany, and the Netherlands would find themselves paying a price.

So before it comes to that, officials in France and Germany are looking to arrange some kind of a rescue -- don’t call it a bailout -- that would have the EU's fiscally strong countries guarantee Greek debt in exchange for a government agreement to implement austerity measures on its budget.

The idea is good, but there are at least two interrelated problems. First, it’s not clear how Germany or the European Commission could enforce any such deal, as nothing in the EU’s setup explicitly contemplates this kind of conditional rescue. Second, while this measure will work as a stopgap, it doesn’t do anything to address Europe's underlying economic problems. Greece’s budget problems are largely about budgeting—years of profligacy and fuzzy accounting got the country into trouble. But Spain, as Paul Krugman has been pointing out, has been a model of fiscal rectitude, running a surplus during the late economic expansion. However, the adoption of the euro is making it very difficult for Spain to weather the current massive recession.

Spain had a Florida-style property boom, which led to massive capital inflows as foreigners invested in Spanish real estate and construction. Spanish wages rose in turn. Then came the crash. In a normal country, the value of Spain’s currency would plummet, making everyone poorer at one swoop but also making Spanish exports cheaper for foreigners to buy and Spanish workers cheaper to hire. That would point the way to recovery. Or if Spain were an American state, it would be supported by federal stimulus dollars, by transfers for Social Security and food stamps, and people would start to move to other states in search of job opportunities.

But Spain and its citizens cannot rely on either of these options. Sure, the European labor market is fairly integrated for a certain kind of high-skill transnational professional. But for your typical middle- or working-class Spaniard, the fact that they don’t speak Spanish in Germany or Finland is a serious impediment to relocating. Consequently, the economies of Spain, Ireland, Portugal, and Italy as well are going to drag along slowly no matter what kind of bailout is organized for Greece. That, in and of itself, is going to lead to budget deficits -- and thus the need for tax hikes and spending cuts -- that will make these economies even weaker. The result is going to be a human catastrophe and could very well lead to a recurring series of Greece-style debt crises that threaten the stability of the overall system.

Skeptics pointed out the possibility of this problem arising when the single currency issue was being debated in Europe. The proponents of the euro, one suspects, weren’t blind to the risks. But they believed in the project of European integration, so they wanted to move forward anyway, thinking that if things got really hairy one day, disaster would only prove the need for deeper integration. That day has arrived. Europe desperately needs not only some kind of bailout for Greece but a standing formal mechanism for dealing with budget crises. Beyond that, it needs an economic policy that works for the whole continent and not just Germany. That means talking about routine fiscal transfers that are targeted at actual economic needs rather than just French farmers. And in the short run, it means a European Central Bank that pays more attention to the present-day problems of Europe’s most economically vulnerable countries than to the hypothetical risk of inflation in its stronger countries like France and Germany.

The decision to assume that deeper fiscal, political, and economic integration could follow currency integration if needed now looks dubious. But the bet was made in the past, and now Europe’s leaders urgently need to follow through on it and plunge ahead with the kind of steps that can make their system workable. To a considerable extent, the fate of the global economy depends on it.